It’s the choice you hoped you’d never have to make.
You’ve run the numbers backward and front. You’ve pored over your budget trying to see what you can cut down. You’ve taken overtime items and tried to sell sitting in your basement, but it’s no use.
You don’t have enough to pay your bills and pay off your secured loan.
Default is an unfortunate reality for millions of Americans. One million people default on student loans alone every year.
If you’re on the brink of default, you might be wondering what would happen if you default on your secured debt.
In this article, we’ll walk you through what you can expect.
What Is Secured Debt?
Banks give loans for one reason: they want the money back.
However, every loan comes with an amount of risk.
Lenders minimize this risk in a number of ways: down payments, interest rates, and cosigners all exist to lower the risk of a loan (this is why borrowers with lower credit scores are charged more interest).
In a secured loan, you offer your own assets to give the lender security that you will pay the loan back. This is called collateral. If you default on a secured loan, you may forfeit these assets to the lender.
This may be the case even if you didn’t specifically offer any collateral.
In a mortgage, the loan is secured against the house itself. In a car loan, it is secured against the car. If you have a tax debt, the IRS may put a tax lien against your home until it is paid back.
Repossession
If you cannot pay back your loan, the collateral you offered may be seized by the lender and sold to make up the difference.
In many states, the assets in question may be repossessed even if you’re a day late on your payment. The specific laws regarding repossession change state to state though.
Repossession cannot be stopped by bankruptcy. In fact, chapter 7 bankruptcy will require you to return your collateral to your lenders before the debt can be stricken from your record.
However, repossession is almost always used as a last-ditch effort. Very rarely will a lender sell the repossessed property for the full value of the loan.
If you are able to pay back your loan over a longer period of time, your lender may be willing to work with you. However, this is at the mercy of the individual loan officer.
How Secured Debt Default Affects Credit Scores
Your credit score is a summation of your relationship with debt. It exists to give lenders an easy metric to identify how risky you are to lend money to.
If you default on a loan, it’s a massive red flag to potential lenders.
Not only will a default tank your credit score, but it will also put a derogatory mark on your credit score that can remain for up to a decade.
While you have that mark on your score, it will be incredibly hard for you to get a loan or open a new credit card.
Avoid Default—At All Costs
Defaulting on secured debt can hurt more than just your credit. You will most likely lose whatever property offered as collateral, leaving you in a much tougher spot than when you were deciding to make payments or not.
If you’re currently on the brink of default, your best chance is to contact your lender to see if they are willing to make an arrangement with you.
For more advice, read this article about the credit scores business owners need to know about.